ATAD III – assessing anti-tax avoidance measures
May 2022 | TALKINGPOINT | CORPORATE TAX
Financier Worldwide Magazine
May 2022 Issue
FW discusses the assessment of anti-tax avoidance measures with Jean Paul Dresen, Luis Muñoz and Sorina van Kommer at DLA Piper.
FW: Could you provide an overview of the drivers behind the European Commission’s (EC’s) anti-tax avoidance directive (ATAD) III? What perceived problems does it seek to redress?
van Kommer: The European Commission’s (EC’s) anti-tax avoidance directive (ATAD) III is based on concerns surrounding legal entities with no or only minimal substance that perform no or very little economic activity and the risk they pose to base erosion and profit shifting or tax avoidance. While this concern has already been addressed by different measures, such as the Anti-Tax Avoidance Directive (2016), there appears to be a general lack of data available on what is the exact impact of the European Union’s (EU’s) already existing tax avoidance toolbox. Furthermore, there are currently no statistics available on ‘shell entities’ in the EU, possibly due to the fact that there is no uniform definition of the term. In addition, so-called shell entities may have valid commercial and business rationales and may not be automatically associated with tax avoidance. Given the lack of solid data and statistics, as well as clear definitions, the impression may be given that the EC’s initiative is based more on political pressure and somewhat incorrect public perceptions regarding the use of these entities.
“As the effects of ATAD I and ATAD II have not been reviewed in full, the timing and final version of ATAD III may still be subject to debate.”
FW: With ATAD following two previous iterations of EU-wide anti-tax avoidance legislation – in 2019 and again in 2020 – in what ways does the existing legislation fail to solve shell company misuse?
Muñoz: While the introduction of a general anti-abuse rule (GAAR) and multilateral instrument (MLI), in combination with the jurisprudence of the Court of Justice of the EU (CJEU), provide the necessary tools for tax authorities to tackle aggressive tax planning schemes, including the misuse of shell entities, they require the active involvement of tax authorities in the different EU member states to be efficient. Hence, many abusive constructs remain unchallenged due to a lack of capacity at the tax authorities’ level. ATAD III simply establishes a minimum substance standard, according to which treaty and directive benefits are automatically denied, if not met, and by doing so, shifts the burden from the tax authorities to the taxpayers. The proposed directive does not, however, solve the problem of misuse of shell companies by itself. The requirements of GAAR, MLI and CJEU case law lay out requirements that go beyond those of ATAD III and they will remain relevant, regardless of how the directive is implemented.
FW: Drilling down, what are the key proposals in the draft ATAD III? How would you characterise the initial response to its provisions across EU member states?
Dresen: ATAD III introduces certain reporting requirements for EU tax resident companies with passive income and a lack of operational substance. First, an EU entity must assess whether it falls within the reporting scope by determining whether it has 75 percent of qualifying, passive income, and performs sufficient cross-border activities as well as outsourcing its operational management in the preceding two years. Secondly, if it must report, the EU entity must inform the relevant tax authority whether it meets a list of certain minimum substance requirements. Thirdly, if the EU entity fails to meet the list of minimum substance requirements, it will lose access to EU directives and tax treaties, the ability to obtain a tax residency certificate and its EU shareholders must include the relevant income of the entity in their own tax return. Finally, an exchange of relevant information will take place within the EU and member states will have the opportunity to impose fines or request for tax audits in respect of a potential, non-compliant EU entity. Most member states seem to be willing to move toward implementation of ATAD III. However, as the effects of ATAD I and ATAD II have not been reviewed in full, the timing and final version of ATAD III may still be subject to debate.
“Entities should assess whether their current governance model may be adapted to potentially avoid reporting obligations foreseen by ATAD III.”
FW: Are any undertakings exempt from ATAD III? What are the consequences for investment structures that do not meet minimum substance requirements?
Dresen: Certain EU entities are exempt from ATAD III, most notably regulated financial companies, such as most qualifying investment funds, companies with transferable securities listed on a regulated market and companies with at least five full-time employees carrying out activities which generate relevant income. Furthermore, a company that meets the entry criteria for ATAD III may, however, request an exemption from its reporting obligation if it can provide evidence that its existence does not reduce the tax liability of the beneficial owners of its group. This exemption is granted for one year and can be extended for up to five years. Investment structures which do have an EU entity that fails to meet the minimum substance requirements may be at risk of suffering an additional tax burden, either because they can no longer rely on exemptions or reduced rates under EU directives or tax treaties, or because any shareholder of such an EU entity must report the entity’s income in their own tax return.
FW: Assuming the draft measures, or similar, are adopted, what steps should companies take now to prepare for compliance?
Muñoz: It is of the essence that entities relying upon the tax benefits foreseen by EU directives or double tax treaties assess whether they need to report under ATAD III, and to the extent this is the case, assess whether sufficient substance is available to comply with the minimum requirements foreseen by the directive. Restructurings in connection with ATAD III minimum substance requirements may imply reallocation of personnel within group entities, finding new premises and even making new hires. The human component of said restructurings cannot be understated. Thus, planning ahead is essential to ensure a smooth transition and to avoid a last-minute rush. Furthermore, the application of the two-year lookback period foreseen by ATAD III to determine whether an entity is subject to reporting requirements is currently under debate. Therefore, entities should assess whether their current governance model may be adapted to potentially avoid reporting obligations foreseen by ATAD III.
“The EC’s proposal is in tune with various international and European initiatives to curb what is perceived as aggressive tax planning.”
FW: What are your expectations for how ATAD III will progress over the coming months? In your opinion, what impact are these measures likely to have on levels of tax evasion and avoidance across the EU?
van Kommer: In order to become law, the EC’s proposal must now be adopted by the Council of the EU, following consultation with the European Parliament. The Council can amend the EC’s text, but changes must be unanimously agreed, as per Article 115 of the Treaty on the Functioning of the EU. Interestingly, the EC has run a consultation on the proposed directive. As with previous directives concerning direct taxation, there will certainly be changes to the proposed language during the negotiation process among member states. However, the trend toward increased tax transparency and higher expectations around substance, as well as the absence of conduit features and commercial rationale for holding structures, has been set at both EU and European domestic level. Furthermore, the EC’s proposal is in tune with various international and European initiatives to curb what is perceived as aggressive tax planning, and its objective is likely to be pursued anyway in some shape or form. The EC needs, however, to ensure that the EU continues to have a level playing field with the rest of the world, without creating new barriers interfering with the smooth functioning of the EU internal market. This is also the reason why the EC announced the issuance of a proposal for shell companies of non-EU member states during 2022.
Jean-Paul Dresen has over 15 years of experience in domestic and international tax, with a particular focus on M&A transactions, including advising both domestic and international corporates, PE firms and hedge funds, corporate restructuring, post-merger or post-acquisition integration matters and capital market transactions. He assisted a number of Dutch, European and US corporates in providing upfront certainty on relevant Dutch tax matters and has assisted clients in specific tax arbitration and tax litigation cases. He can be contacted on +31 (0)20 5419 804 or by email: jeanpaul.dresen@dlapiper.com.
Luis Muñoz focuses on international and corporate tax law, particularly on the tax aspects of cross-border private equity, real estate and debt investments and the tax structuring of regulated and unregulated investment platforms. He also advises on the tax elements of corporate restructurings and M&A transactions. He can be contacted on +352 (26) 2904 2633 or by email: luis.munoz@dlapiper.com.
Sorina van Kommer is the international head of knowledge for the tax practice group at DLA Piper, responsible for developing, leading and managing the group’s knowledge strategy and working with the group’s knowledge partners and the wider knowledge community across the firm to deliver on its overarching knowledge and the tax group’s business strategy. She can be contacted on +31 (20) 541 9373 or by email: sorina.vankommer@dlapiper.com.
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